Click on the image above to download a copy of the discussion draft of the proposed legislation.

Recent commodity broker bankruptcies have exposed flaws in the protection scheme afforded to commodity customers. Customer protections are authorized by the Commodity Exchange Act, which must be re-authorized by Congress every 5 years. The re-authorization process affords the opportunity to enact reforms vital to protecting customers from broker malfeasance.

The Commodity Customer Protection Act aims to enhance customer protections by restoring their first-priority right in broker bankruptcies and by addressing account classes for customer account types not contemplated by the Act. For more information on the backgdound of this bill, please click the "Understanding this Bill" tab above.

Please download the discussion draft of the legislation by clicking on the image to the left.

For more information, please click on the tabs above.

SECTION 2

Restoring Customer Priority in Bankruptcy Through Subordination

One of the biggest problems facing commodity customers is the status of their priority over other creditors in a broker bankruptcy. Commodity brokers are required to keep customer property "segregated" or completely separate from their own assets. If a broker fails, customer property is not affected. However, if a broker breaks the rules and misappropriates customer property, the defunct broker's assets should repay customers first since the broker broke the law and took their money out of segregation. This was the original intent of Congress.

Recent broker bankruptcies have exposed that there is a conflict between Chapter 7 of the Bankruptcy Code and Part 190 of Title7/Chapter 1 of the Code of Federal Regulations regarding how commodity customers are treated in bankruptcy. Section 2 of the Commodity Customer Protection Act seeks to remedy this by requiring that commodity brokers use subordination agreements with certain creditors. It re-establishes how the entire commodity industry thought the law protected customers for decades: commodity customers have the right to get property returned to them in full first over every other creditor.

How Does Subordination Work?

Section 2 requires commodity brokers to use agreements with their affiliates and lenders which subordinate their claims to customer claims. Without producing a stay on a bankruptcy proceeding, it is not practical to reshuffle bankruptcy priorities without amending the Bankruptcy Code. However, the Code fully contemplates that creditors can agree to subordinate debt between counterparties (11 USC 510). Section 2 limits the use of those subordination agreements to intercompany affiliates and those who provide financing to the broker, carving out smaller vendors and service providers.

How Does this Help Customers in Bankruptcy?

If a commodity broker does not have enough customer money to fully repay customers, subordination agreements would establish a de facto first priority right for customer claims to the broker's property. Consider this very simple example. I send $100 to my broker to hold in my brokerage account. The broker removes $40 of my money and places it in its own account. The broker then goes bankrupt. Under the current law, I could receive $60 back and may have to split the $40 my broker took from me with other creditors. If those other creditors agreed to subordinate their claims to mine, then I would receive the full $100 back before the other creditors could get any money.

Requiring subordination agreements would also prevent legal tactics from delaying the return of customer property. MF Global's UK affiliate delayed the return of customer money by placing large claims on the US customers' property pool. This the claim may have had little basis in law, so the move was likely a legal tactic to aid in negotiations for the affiliate's creditors. Even though these claims were frivolous, the Trustee had to hold back customer property in reserve against those claims. Subordination agreements would allow the Trustee to distribute customer property more quickly, as affiliates and lenders would have already agreed in advance that their claims have a lower priority than the claims of customers.

Why Not Change the Bankruptcy Code?

The broker bankruptcy which exposed that customers do not have a first priority right happened in 1999(Griffin Trading Co.). In the 14 years since, despite an opportunity in 2005 to amend the Bankruptcy Code, there has been no effort to change the Code to amend commodity customer priority. It is widely believed that an attempt to amend the Code would prove futile, given the legislative battle which would unfold if the Code were open to amendment. If the amending the bankruptcy code is a bridge to far, then the re-authorization of the Commodity Exchange Act presents the best opportunity to provide customers with priority.

SECTION 3

Establishing New Account Classes for Safekeeping and Retail Forex Accounts

When a commodity broker goes bankrupt, the Code of Federal Regulations (17 CFR 190.08(c)) directs the bankruptcy Trustee for the failed brokerage to separate customers according to five account classes (soon to be six with the addition of cleared swaps). Recent broker bankruptcies and new developments in the industry demonstrate the need for two new accounts classes: Safekeeping Accounts and Retail Forex Accounts.

Safekeeping Accounts

As a reaction to recent bankruptcies and as a result of the centralized clearing of swaps, new collateral arrangements are being developed which would permit customers to keep their property at a custodian rather than a commodity broker (see page 3, Safekeeping Accounts). Simply put, a commodity customer could place funds to margin trades with a custody bank instead of sending the money directly to a broker. These accounts have been deemed 'safekeeping accounts', as they put assets out of the hands of brokers for safekeeping.

While these accounts are not active now and this bill does not prescribe a way for them to operate, if they become a reality Safekeeping Accounts will present problems if they are not recognized as a separate account class in bankruptcy. Section 3 provides a definition for Safekeeping Accounts and directs a bankrupt broker's Trustee to recognize them as a separate account class.

An added benefit of creating this designation is that it makes Safekeeping Accounts more 'bankruptcy remote'. One of the common criticisms of Safekeeping Accounts as a mitigant of broker malfeasance is that even if you have one such account, you are still 'on the hook' for any loss if your broker goes down and takes customer money with it. This is because property is distributed to customers on a pro rata basis. Therefore any loss in customer property is shared between customers pro rata, regardless of whether or not customer money is held by the broker or a bank. However, if Safekeeping Accounts are recognized as their own account class, then it would be impossible for a loss resulting from broker malfeasance to affect them.

This is because property is distributed pro rata to each account class. For example, if a shortfall in customer property arose from foreign futures accounts, then the loss is limited to customers who have assets in that account class. To use a simple example, suppose I send $100 to my broker to trade foreign futures and I put $100 in a safekeeping account to trade US futures. If the broker goes bankrupt with a shortfall of 20% in foreign futures accounts, I would receive $80 back from my foreign futures accounts, but $100 in my safekeeping account. Customers with assets only in the Safekeeping Account class would receive all of their money. Since the money would be held at a bank, it is impossible for the broker to misappropriate it.

Retail Forex Accounts

Retail Forex Customers engage in off-exchange over-the-counter transactions in currencies. In the bankruptcy of Peregrine Financial Group, Retail Forex Customer accounts held about $41 million and were intact with no shortfall at the time of the bankruptcy. Under present law, their funds could be divvied up among general creditors. Section 3 defines Retail Forex Accounts and directs Trustees to recognize them as a separate account class. Combined with the extension of segregation protections to Retail Forex Property in Section 4, this should prevent general creditors of bankrupt brokers from being able to receive funds which belong to Retail Forex Customers.

SECTION 4

Requiring Segregation for Retail Forex Property

At this time, commodity brokers who facilitate retail over-the-counter trades in foreign currencies are not required to segregate the property of those customers from broker assets. The concept of segregated accounts is a cornerstone of the commodity futures industry, but since over-the-counter forex trades are not exchange cleared like futures, they receive no such protections. Therefore, commodity brokers have different pools of property subject to different regulations. In effort to standardize these, and to extend Retail Forex Customers the same protections as their commodity futures counterparts, Section 4 requires that commodity brokers segregate Retail Forex Customer property from their own.

The bankruptcies of MF Global and Peregrine Financial Group ensnared over 63,000 customer accounts in every US state and dozens of countries across the world. The CCC is in the process of mapping claimants in commodity broker bankruptcies so Members of Congress can see how many of their constituents have been affected by lax customer protections. At this time the map below contains data from the MF Global bankruptcy only. Mouse-over the map below for claims information by state.

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Interested in helping reform the commodities industry? The CCC is working on a variety of initiatives to strengthen the legal protections for customer property. We need your help for these efforts to succeed.